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Chapter9-1
Inventories: Additional
Valuation Issues
Chapter9
Intermediate Accounting12th Edition
Kieso, Weygandt, and Warfield
Prepared by Coby Harmon, University of California, Santa Barbara
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Chapter9-2
1. Describe and apply the lower-of-cost-or-market rule.2. Explain when companies value inventories at net realizable
value.
3. Explain when companies use the relative sales value method
to value inventories.4. Discuss accounting issues related to purchase
commitments.
5. Determine ending inventory by applying the gross profit
method.6. Determine ending inventory by applying the retail inventory
method.
7. Explain how to report and analyze inventory.
Learning Objectives
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Chapter9-3
Inventories: Additional Valuation Issues
Net realizable
value
Relative sales
value
Purchase
commitments
Lower-of-
Cost-or-
Market
Valuation
Bases
Gross Profit
Method
Retail
Inventory
Method
Presentation
and Analysis
Ceiling and
floor
How LCM
works
Application of
LCM
Market
Evaluation of
rule
Gross profit
percentage
Evaluation of
method
Concepts
Conventional
method
Special items
Evaluation of
method
Presentation
Analysis
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Chapter9-4
Market = Replacement Cost
Lower of Cost or Replacement Cost
Loss should be recorded when loss occurs, not in theperiod of sale.
A company abandons the historical cost principle whenthe future utility (revenue-producing ability) of the
asset drops below its original cost.
Lower-of-Cost-or-Market
LO 1 Describe and apply the lower-of-cost-or-market rule.
LCM
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Chapter9-5
Decline in the RC usually = decline in selling price.
RC allows a consistent rate of gross profit.
If reduction in RC fails to indicate reduction in utility,then two additional valuation limitations are used:
Ceiling- net realizable value and
Floor- net realizable value less a normal profit margin.
Why use Replacement Cost (RC) for Market?
Lower-of-Cost-or-Market
LO 1 Describe and apply the lower-of-cost-or-market rule.
Ceiling and Floor
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Chapter9-6
Not
Illustration 9-3
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Chapter9-7
Ceilingprevents overstatement of the value ofobsolete, damaged, or shopworn inventories.
Floordeters understatement of inventory andoverstatement of the loss in the current period.
Lower-of-Cost-or-Market
LO 1 Describe and apply the lower-of-cost-or-market rule.
Rationale for Limitations
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Chapter9-8
Lower-of-Cost-or-Market
LO 1 Describe and apply the lower-of-cost-or-market rule.
How LCM Works (Individual Items)
Illustration 9-5
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Chapter9-9
Lower-of-Cost-or-Market
LO 1 Describe and apply the lower-of-cost-or-market rule.
Methods of Applying LCM
Illustration 9-6
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Chapter9-10 LO 1 Describe and apply the lower-of-cost-or-market rule.
Lower-of-Cost-or-Market
Recording LCM (data from Illus. 9-5 and 9-6)
Ending inventory (cost) $ 415,000
Ending inventory (LCM) 350,000
Adjustment to LCM $ 65,000
Allowance on inventory 65,000
Loss on inventory 65,000
Inventory 65,000
Cost of goods sold 65,000
AllowanceMethod
DirectMethod
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Chapter9-11
Allowance Direct
Current assets:
Cash 100,000$ 100,000$
Accounts receivable 350,000 350,000
Inventory 770,000 705,000
Less: inventory allowance (65,000)
Prepaids 20,000 20,000
Total current assets 1,175,000 1,175,000
LO 1 Describe and apply the lower-of-cost-or-market rule.
Lower-of-Cost-or-Market
Balance Sheet Presentation
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Chapter9-12
Allowance Direct
Sales 300,000$ 300,000$Cost of goods sold 120,000 185,000
Gross profit 180,000 115,000
Operating expenses:
Selling 45,000 45,000
General and administrative 20,000 20,000Total operating expenses 65,000 65,000
Other revenue and expense:
Loss on inventory 65,000 -
Interest income 5,000 5,000
Total other (60,000) 5,000
Income from operations 55,000 55,000
Income tax expense 16,500 16,500
Net income 38,500$ 38,500$
LO 1 Describe and apply the lower-of-cost-or-market rule.
Lower-of-Cost-or-Market
Income Statement Presentation
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Chapter9-13
P9-1 Grant Wood Company manufactures desks. The companyattempts to obtain a 20% gross margin on selling price. AtDecember 31, 2008, the following finished desks appear in thecompanys inventory.
Instructions:
At what amount should the desks appear in the companys December 31,2008, inventory, assuming that the company has adopted a lower-of-cost-or-market approach for valuation of inventories on an individual-item basis?
Finished Desks A B C D
Inventory cost 470$ 450$ 830$ 960$Est. cost to manufacture 460 440 610 1,000
Commissions and disposal costs 45 60 90 130
Catalog selling price 500 540 900 1,200
Lower-of-Cost-or-Market
LO 1 Describe and apply the lower-of-cost-or-market rule.
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Chapter9-14
Not
Finished Desks A
Inventory cost 470$
Est. cost to manufacture 460
Commissions and disposal costs 45
Catalog selling price 500
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Chapter9-15
Not
Finished Desks B
Inventory cost 450$
Est. cost to manufacture 440
Commissions and disposal costs 60
Catalog selling price 540
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Chapter9-16
Not
Finished Desks C
Inventory cost 830$
Est. cost to manufacture 610
Commissions and disposal costs 90
Catalog selling price 900
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Chapter9-17
Not
Finished Desks D
Inventory cost 960$
Est. cost to manufacture 1,000
Commissions and disposal costs 130
Catalog selling price 1,200
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Chapter9-18
Expense recorded when loss in utility occurs. Profit onsale recognized at the point of sale.
Inventory valued at cost in one year and at market in thenext year.
Net income in year of loss is lower. Net income in
subsequent period may be higher than normal if expectedreductions in sales price do not materialize.
LCM uses a normal profit in determining inventoryvalues, which is a subjective measure.
Some Deficiencies:
Lower-of-Cost-or-Market
LO 1 Describe and apply the lower-of-cost-or-market rule.
Evaluation of LCM Rule
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Chapter9-19
(1) a controlled market with a quoted price applicable to
all quantities, and(2) no significant costs of disposal (rare metals and
agricultural products)
or(3) too difficult to obtain cost figures (meatpacking)
Permitted by GAAP under the following conditions:
Valuation Bases
LO 2 Explain when companies value inventories at net realizable value.
Net Realizable Value
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Chapter9-20
Used when buying varying units in a single lump-sum purchase.
Valuation Bases
LO 3 Explain when companies use the relativesales value method to value inventories.
Relative Sales Value
E9-7 (Relative Sales Value Method)Phil Collins Realty Corporationpurchased a tract of unimproved land for $55,000. This land was improved
and subdivided into building lots at an additional cost of $34,460. Thesebuilding lots were all of the same size but owing to differences in locationwere offered for sale at different prices as follows. Operating expensesallocated to this project total $18,200.
Instructions:Calculate
the net income realizedon this operation todate.
No. of Price Lots UnsoldGroup Lots per Lot at Year-End
1 9 3,000$ 5
2 15 4,000 7
3 17 2,400 2
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Chapter9-21
Valuation Bases
LO 3 Explain when companies use the relativesales value method to value inventories.
E9-7 (Relative Sales Value Method - Solution)No. of Price Selling Relative Total Cost Cost
Group Lots per Lot Price Sales Price Cost Allocated Per Lot
1 9 3,000$ 27,000$ $27,000/127,800 89,460$ 18,900$ 2,100$
2 15 4,000 60,000 60,000/127,800 89,460 42,000 2,800
3 17 2,400 40,800 40,000/127,800 89,460 28,560 1,680
127,800$ 89,460$
Lots Price Total Cost Total Cost Calculation of Net IncomeGroup Sold per Lot Sales Per Lot of Goods Sales 80,000
1 4 3,000$ 12,000$ 2,100$ 8,400$ Cost of good sold 56,0002 8 4,000 32,000 2,800 22,400 Gross profit 24,000
3 15 2,400 36,000 1,680 25,200 Expenses 18,200
80,000$ 56,000$ Net income 5,800$
x = x =
=x
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Chapter9-22
Generally seller retains title to the merchandise.
Buyer recognizes no asset or liability.
If material, the buyer should disclose contract details infootnote.
If the contract price is greater thanthe market price,and the buyer expects that losses will occurwhen the
purchase is effected, the buyer should recognize lossesin the period during which such declines in market pricestake place.
Valuation Bases
LO 4 Discuss accounting issues related to purchase commitments.
Purchase Commitments
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Chapter9-23
Relies on Three Assumptions:
Gross Profit Method
LO 5 Determine ending inventory by applying the gross profit method.
Substitute Measure to Approximate Inventory
(1) Beginning inventory plus purchases equal total goods to
be accounted for.(2) Goods not sold must be on hand.
(3) The sales, reduced to cost, deducted from the sum ofthe opening inventory plus purchases, equal endinginventory.
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Chapter9-24
E9-12 (Gross Profit Method)Mark Price Company uses thegross profit method to estimate inventory for monthlyreporting purposes. Presented below is information for themonth of May.
Instructions:
(a)Compute the estimated inventory at May 31, assuming that the grossprofit is 30% of sales.
(b)Compute the estimated inventory at May 31, assuming that the grossprofit is 30% of cost.
Inventory, May 1 160,000$
Purchases (gross) 640,000Freight-in 30,000
Sales 1,000,000
Sales returns 70,000
Purchase discounts 12,000
Gross Profit Method
LO 5 Determine ending inventory by applying the gross profit method.
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Chapter9-25
E9-12 (Gross Profit Method - Solution)
(a) Inventory, May 1 (at cost) $ 160,000
Purchases (gross) (at cost) 640,000
Purchase discounts (12,000)
Freight-in 30,000
Goods available (at cost) 818,000
Sales (at selling price) $ 1,000,000
Sales returns (at selling price) (70,000)
Net sales (at selling price) 930,000Less gross profit (30% of $930,000) 279,000
Sales (at cost) 651,000
Approximate inventory, May 31 (at cost) $ 167,000
(a)Compute the estimated inventory assuming gross profit is 30% of sales.
Gross Profit Method
LO 5 Determine ending inventory by applying the gross profit method.
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Chapter9-26
(a) Inventory, May 1 (at cost) $ 160,000
Purchases (gross) (at cost) 640,000
Purchase discounts (12,000)
Freight-in 30,000
Goods available (at cost) 818,000
Sales (at selling price) $ 1,000,000
Sales returns (at selling price) (70,000)
Net sales (at selling price) 930,000Less gross profit (23.08% of $930,000) 214,644
Sales (at cost) 715,356
Approximate inventory, May 31 (at cost) $ 102,644
E9-12 (Gross Profit Method - Solution)(b)Compute the estimated inventory assuming gross profit is 30% of cost.
Gross Profit Method
LO 5 Determine ending inventory by applying the gross profit method.
30%
100% + 30%
= 23.08% of sales
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Chapter9-27
Disadvantages:
Gross Profit Method
LO 5 Determine ending inventory by applying the gross profit method.
Evaluation:
(1) Provides an estimate of ending inventory.
(2) Uses past percentages in calculation.
(3) A blanket gross profit rate may not be representative.
(4) Only acceptable for interim (generally quarterly)
reporting purposes.
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Chapter9-28
Retail Inventory Method
LO 6 Determine ending inventory by applying the retail inventory method.
A method used by retailers, to value inventory withouta physical count, by converting retail prices to cost.
(1) the total cost and retail value of goods purchased,(2) the total cost and retail value of the goods available
for sale, and
(3) the sales for the period.
Requires retailers to keep:
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Chapter
9-29
P9-8 (Retail Inventory Method)Jared Jones Inc. uses theretail inventory method to estimate ending inventory for itsmonthly financial statements. The following data pertain to asingle department for the month of October 2008.
Retail Inventory Method
COST RETAIL
Beg. inventory, Oct. 1 52,000$ 78,000$
Purchases 262,000 423,000
Freight in 16,600
Purchase returns 5,600 8,000
Additional markups 9,000
Markup cancellations 2,000Markdowns (net) 3,600
Normal spoilage 10,000
Sales 380,000
Instructions:
Prepare a schedulecomputing estimateretail inventoryusing the following
methods:(1)Cost
(2)LCM
(3)LIFO (appendix)
LO 6 Determine ending inventory by applying the retail inventory method.
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Chapter
9-30
Retail Inventory - Cost Method
LO 6 Determine ending inventory by applying the retail inventory method.
P9-8 Solution - Cost Method Cost toCOST RETAIL Retail %
Beg. inventory 52,000$ 78,000$
Purchases 262,000 423,000
Freight in 16,600
Purchase returns (5,600) (8,000)
Markdowns, net (3,600)Markups, net 7,000
Current year additions 273,000 418,400
Goods available for sale 325,000 496,400 65.47%
Normal spoilage (10,000)
Sales (380,000)
Ending inventory at retail 106,400$
Ending inventory at Cost:
106,400$ x 65.47% = 69,660$
=/
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Chapter
9-31
Retail Inventory - LCM Method
LO 6 Determine ending inventory by applying the retail inventory method.
P9-8 Solution - LCM (CONVENTIONAL) Method:Cost to
COST RETAIL Retail %
Beg. inventory 52,000$ 78,000$
Purchases 262,000 423,000
Freight in 16,600
Purchase returns (5,600) (8,000)Markups, net 7,000
Current year additions 273,000 422,000
Goods available for sale 325,000 500,000 65.00%
Markdowns, net (3,600)
Normal spoilage (10,000)
Sales (380,000)Ending inventory at retail 106,400$
Ending inventory at Cost:
106,400$ x 65.00% = 69,160$
=/
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Chapter
9-32
Retail Inventory - LIFO Method
LO 8 Determine ending inventory by applying the LIFO retail inventory methods.
P9-8 Solution - LIFO Method: Cost toCOST RETAIL Retail %
Beg. inventory 52,000$ 78,000$ 66.67%
Purchases 262,000 423,000
Freight in 16,600
Purchase returns (5,600) (8,000)
Markdowns, net (3,600)Markups, net 7,000
Current year additions 273,000 418,400 65.25%
Goods available for sale 325,000 496,400
Normal spoilage (10,000)
Sales (380,000)
Ending inventory at retail 106,400$
Ending inventory at Cost:
PY 78,000$ x 66.67% = 52,000$
CY 28,400 x 65.25% = 18,531
106,400$ 70,531$
=/
=/
Appendix 9A
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Chapter
9-33
Widely used for the following reasons:Evaluation:
(1) to permit the computation of net income without a
physical count of inventory,(2) as a control measure in determining inventory
shortages,
(3) in regulating quantities of merchandise on hand, and
(4) for insurance information.
Retail Inventory Method
LO 6 Determine ending inventory by applying the retail inventory method.
Some companies refine the retail method by computing inventory separatelyby departments or class of merchandise with similar gross profits.
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Chapter
9-34
Accounting standards require disclosure of:
Presentation and Analysis
LO 7 Explain how to report and analyze inventory.
Presentation:
(1) composition of the inventory,
(2) financing arrangements, and
(3) costing methods employed.
Common ratios used in the management and evaluation ofinventory levels are inventory turnoverand average daysto sell the inventory.
Analysis:
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Chapter
9-35
Measures the number of times on average a companysells the inventory during the period.
Presentation and Analysis
LO 7 Explain how to report and analyze inventory.
Inventory Turnover Ratio
Illustration 9-26
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Chapter
9-36
Measure represents the average number of dayssales for which a company has inventory on hand.
Presentation and Analysis
LO 7 Explain how to report and analyze inventory.
Average Days to Sell Inventory
365 days / 8 times = every 45.6 days
Inventory Turnover
Average Days to Sell
Illustration 9-26
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Chapter
9 37
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